TECHNICAL EXPLANATION OF H.R. 2596, 

THE “HEALTH SAVINGS AND 

AFFORDABILITY ACT OF 2003,”

AS PASSED BY THE HOUSE OF REPRESENTATIVES

ON JUNE 26, 2003

Prepared by the Staff

of the

JOINT COMMITTEE ON TAXATION

June 30, 2003

JCX-66-03
i

CONTENTS

Page

INTRODUCTION .......................................................................................................................... 1

I. EXPLANATION OF THE BILL ............................................................................................... 2

A. Health Savings Accounts and Health Savings Security Accounts

 (sec. 2 of the bill and new secs. 223 and 224 of the Code)................................................. 2

B. Disposition of Unused Health Benefits in Flexible Spending Arrangements 

 (sec. 3 of the bill and sec. 125 of the Code)...................................................................... 12

C. Exception to Information Reporting Requirements for Certain Health Arrangements 

 (sec. 4 of the bill and sec. 6041 of the Code).................................................................... 14
1

INTRODUCTION

This document,1 prepared by the staff of the Joint Committee on Taxation, provides a 

technical explanation of H.R. 2596, the “Health Savings and Affordability Act of 2003,” as 

passed by the House of Representatives on June 26, 2003.2

 

1

 This document may be cited as follows: Joint Committee on Taxation, Technical 

Explanation of H.R. 2596, the “Health Savings and Affordability Act of 2003,” as passed by the 

House of Representatives on June 26, 2003 (JCX-66-03), June 30, 2003.

2

 The House Committee on Ways and Means reported out another bill, H.R. 2351, 

relating to health savings accounts on June 25, 2003. H.R. REP. NO. 108-177 (2003).
2

I. EXPLANATION OF THE BILL

A. Health Savings Accounts and Health Savings Security Accounts

(sec. 2 of the bill and new secs. 223 and 224 of the Code)

Present Law

Overview

Present law contains a number of provisions dealing with the Federal tax treatment of 

health expenses and health insurance coverage. 

Employer-provided health coverage

In general, employer contributions to an accident or health plan are excludable from an 

employee’s gross income (and wages for employment tax purposes).3 This exclusion generally 

applies to coverage provided to employees (including former employees) and their spouses, 

dependents, and survivors. Benefits paid under employer-provided accident or health plans are 

also generally excludable from income to the extent they are reimbursements for medical care.4 

If certain requirements are satisfied, employer-provided accident or health coverage offered 

under a cafeteria plan is also excludable from an employee’s gross income and wages.5

Present law provides for two general employer-provided arrangements that can be used to 

pay for or reimburse medical expenses of employees on a tax-favored basis: flexible spending 

arrangements (“FSAs”) and health reimbursement arrangements (“HRAs”). While these 

arrangements provide similar tax benefits (i.e., the amounts paid under the arrangements for 

medical care are excludable from gross income and wages for employment tax purposes), they 

are subject to different rules. A main distinguishing feature between the two arrangements is that 

while FSAs are generally part of a cafeteria plan and contributions to FSAs are made on a salary 

reduction basis, HRAs cannot be part of a cafeteria plan and contributions cannot be made on a 

salary-reduction basis.6

 

3

 Secs. 106, 3121(a)(2), and 3306(b)(2). All “section,” “sec.,” and “Code” references 

are to the Internal Revenue Code of 1986, as amended. 

4

 Sec. 105. In the case of a self-insured medical reimbursement arrangement, the 

exclusion applies to highly compensated employees only if certain nondiscrimination rules are 

satisfied. Sec. 105(h). Medical care is defined as under section 213(d) and generally includes 

amounts paid for qualified long-term care insurance and services.

5

 Secs. 125, 3121(a)(5)(G), and 3306(b)(5)(G). Long-term care insurance and services 

may not be provided through a cafeteria plan.

6

 Notice 2002-45, 2002-28 I.R.B. 93 (July 15, 2002); Rev. Rul. 2002-41, 2002-28 I.R.B. 

75 (July 15, 2002).
3

Amounts paid or accrued by an employer within a taxable year for a sickness, accident, 

hospitalization, medical expense, or similar health plan for its employees are generally 

deductible as ordinary and necessary business expenses.7

Self-employed individuals

The exclusion for employer-provided health coverage does not apply to self-employed 

individuals. However, under present law, self-employed individuals (i.e., sole proprietors or 

partners in a partnership)8 are entitled to deduct 100 percent of the amount paid for health 

insurance for themselves and their spouse and dependents.9

Itemized deduction for medical expenses

Under present law, individuals who itemize deductions may deduct amounts paid during 

the taxable year (to the extent not reimbursed by insurance or otherwise) for medical care of the 

taxpayer, the taxpayer’s spouse, and dependents, to the extent that the total of such expenses 

exceeds 7.5 percent of the taxpayer’s adjusted gross income.10

Archer medical savings accounts

In general

In general, an Archer medical savings account (“MSA”) is a tax-exempt trust or custodial 

account created exclusively for the benefit of the account holder that is subject to rules similar to 

those applicable to individual retirement arrangements.11

Within limits, contributions to an Archer MSA are deductible in determining adjusted 

gross income if made by an eligible individual and are excludable from gross income and wages 

for employment tax purposes if made by the employer of an eligible individual. Earnings on 

amounts in an Archer MSA are not includible in gross income in the year earned (i.e., inside 

buildup is not taxable). Distributions from an Archer MSA for qualified medical expenses are 

not includible in gross income. Distributions not used for qualified medical expenses are 

includible in gross income and subject to an additional 15-percent tax unless the distribution is 

made after death, disability, or the individual attains the age of Medicare eligibility (i.e., age 65).

 

7

 Sec. 162.

8

 Self-employed individuals include more than two-percent shareholders of S 

corporations who are treated as partners for purposes of fringe benefit rules pursuant to section 

1372.

9

 Sec. 162(l).

10 Sec. 213. The adjusted gross income percentage is 10 percent for purposes of the 

alternative minimum tax. Sec. 56(b)(1)(B).

11 Sec. 220.
4

Qualified medical expenses are generally defined as under section 213(d), except that 

qualified medical expenses do not include expenses for health insurance other than long-term 

care insurance, premiums for health coverage during any period of continuation coverage 

required by Federal law, and premiums for health care coverage while an individual is receiving 

unemployment compensation under Federal or State law. For purposes of determining the 

itemized deduction for medical expenses, distributions from an Archer MSA for qualified 

medical expenses are not treated as expenses paid for medical care under section 213.

Eligible individuals

Archer MSAs are available only to employees of a small employer who are covered 

under an employer-sponsored high deductible health plan and to self-employed individuals 

covered under a high deductible health plan.12 An employer is a small employer if it employed, 

on average, no more than 50 employees on business days during either of the two preceding 

calendar years. An individual is not eligible for an Archer MSA if he or she is covered under 

any other health plan that is not a high deductible health plan (other than a plan providing certain 

limited types of coverage). Individuals entitled to benefits under Medicare are not eligible 

individuals. Eligible individuals do not include individuals who may be claimed as a dependent 

on another person’s tax return.

Treatment of contributions

Individual contributions to an Archer MSA are deductible (within limits) in determining 

adjusted gross income (i.e., “above-the-line”). In addition, employer contributions are 

excludable from gross income and wages for employment tax purposes (within the same limits), 

except that this exclusion does not apply to contributions made through a cafeteria plan. In the 

case of an employee, contributions can be made to an Archer MSA either by the individual or by 

the individual’s employer, but not by both.

The maximum annual contribution that can be made to an Archer MSA for a year is 65 

percent of the annual deductible under the high deductible health plan in the case of self-only 

coverage and 75 percent of the annual deductible in the case of family coverage.

If an employer provides a high deductible health plan coupled with Archer MSAs for 

employees and makes employer contributions to the Archer MSAs, the employer must make 

available a comparable contribution on behalf of all employees with comparable coverage during 

the same period. Contributions are considered comparable if they are either of the same amount 

or the same percentage of the deductible under the high deductible health plan. If employer 

contributions do not satisfy the comparability rule during a period, then the employer is subject 

to an excise tax equal to 35 percent of the aggregate amount contributed by the employer to 

Archer MSAs of the employer for that period. 

 

12 Self-employed individuals include more than two-percent shareholders of S 

corporations who are treated as partners for purposes of fringe benefit rules pursuant to section 

1372.
5

Definition of high deductible health plan

A high deductible health plan is a health plan with an annual deductible of at least $1,700 

and no more than $2,500 in the case of self-only coverage and at least $3,350 and no more than 

$5,050 in the case of family coverage. In addition, the maximum out-of-pocket expenses with 

respect to allowed costs (including the deductible) must be no more than $3,350 in the case of 

self-only coverage and no more than $6,150 in the case of family coverage.13 A plan does not 

fail to qualify as a high deductible health plan merely because it does not have a deductible for 

preventive care as required under State law. A plan does not qualify as a high deductible health 

plan if substantially all of the coverage under the plan is certain permitted insurance or is 

coverage (whether provided through insurance or otherwise) for accidents, disability, dental care, 

vision care, or long-term care. 

Treatment of death of account holder

Upon death, any balance remaining in the decedent’s Archer MSA is includible in his or 

her gross estate. If the account holder’s surviving spouse is the named beneficiary of the Archer 

MSA, then, after the death of the account holder, the Archer MSA becomes the Archer MSA of 

the surviving spouse and the amount of the Archer MSA balance may be deducted in computing 

the decedent’s taxable estate, pursuant to the estate tax marital deduction.14 If, upon the account 

holder’s death, the Archer MSA passes to a named beneficiary other than the decedent’s 

surviving spouse, the Archer MSA ceases to be an Archer MSA as of the date of the decedent’s 

death, and the beneficiary is required to include the fair market value of the Archer MSA assets 

as of the date of death in gross income for the taxable year that includes the date of death. The 

amount includible in gross income is reduced by the amount in the Archer MSA used, within one 

year after death, to pay qualified medical expenses incurred prior to the death. If there is no 

named beneficiary for the decedent’s Archer MSA, the Archer MSA ceases to be an Archer 

MSA as of the date of death, and the fair market value of the assets in the Archer MSA as of 

such date is includible in the decedent’s gross income for the year of the death.

Limit on number of MSAs; termination of MSA availability

The number of taxpayers benefiting annually from an Archer MSA contribution is limited 

to a threshold level (generally 750,000 taxpayers). The number of Archer MSAs established has 

not exceeded the threshold level.

After 2003, no new contributions can be made to Archer MSAs except by or on behalf of 

individuals who previously had Archer MSA contributions and employees who are employed by 

a participating employer.

 

13 The deductible and out-of-pocket expenses dollar amounts are for 2003. These 

amounts are indexed for inflation in $50 increments.

14 Sec. 2056.
6

Explanation of Provision

In general

The provision creates health savings accounts (“HSAs”) and health savings security 

accounts (“HSSAs”) which provide tax-favored treatment for current medical expenses as well 

as the ability to save on a tax-favored basis for future medical expenses. In general, HSAs and 

HSSAs are tax-exempt trusts or custodial accounts created exclusively to pay for the qualified 

medical expenses of the account holder and his or her spouse and dependents that are subject to 

rules similar to those applicable to individual retirement arrangements.15 Unless otherwise 

provided, the following description applies to both HSAs and HSSAs (jointly referred to as 

“health accounts”).

Within limits, contributions to health accounts are deductible if made by an eligible 

individual and are excludable from gross income and wages for employment tax purposes if 

made by the employer of an eligible individual. In the case of HSSAs only, family members 

may make nondeductible contributions on behalf of an eligible individual. Distributions from 

health accounts for qualified medical expenses are not includible in gross income. Distributions 

that are not for qualified medical expenses are includible in gross income and subject to an 

additional 15 percent tax. The additional 15 percent tax does not apply after death, disability, or 

the individual attains the age of Medicare eligibility (i.e., age 65).

Eligible individuals

HSAs

Eligible individuals for HSAs are individuals who are covered by a high deductible 

health plan and no other health plan that is not a high deductible health plan. Individuals entitled 

to benefits under Medicare are not eligible individuals. Eligible individuals do not include 

individuals who may be claimed as a dependent on another person’s tax return. 

An individual with other coverage in addition to a high deductible health plan is still 

eligible for an HSA if such other coverage is certain permitted insurance or permitted coverage. 

Permitted insurance is: (1) insurance if substantially all of the coverage provided under such 

insurance relates to (a) liabilities incurred under worker’s compensation law, (b) tort liabilities, 

(c) liabilities relating to ownership or use of property (e.g., auto insurance), or (d) such other 

similar liabilities as the Secretary may prescribe by regulations; (2) insurance for a specified 

disease or illness; and (3) insurance that provides a fixed payment for hospitalization. Permitted 

coverage is coverage (whether provided through insurance or otherwise) for accidents, disability, 

dental care, vision care, or long-term care. 

A high deductible health plan is a health plan that in the case of self-only coverage has an 

annual deductible between $1,000 and $2,500 and in the case of family coverage has an annual 

 

15 The provision provides that the present-law requirement applicable to insurance 

companies that certain policy acquisition expenses must be capitalized and amortized (sec. 848) 

does not apply in the case of any contract that is a health account.
7

deductible between $2,000 and $5,050.16 The maximum out-of-pocket expenses must be no 

more than $3,350 in the case of self-only coverage and no more than $6,150 in the case of family 

coverage. The annual deductible maximum and minimum and out-of-pocket expense amounts 

are indexed for inflation. A plan is not a high deductible health plan if substantially all of the 

coverage is for permitted coverage or coverage that may be provided by permitted insurance, as 

described above.

HSSAs

Individuals eligible for HSSAs are individuals who (1) are covered under a health plan 

meeting minimum deductible requirements and no other health plan that does not meet the 

minimum deductible requirements, or (2) are uninsured. Individuals entitled to benefits under 

Medicare are not eligible individuals. Eligible individuals do not include individuals who may 

be claimed as a dependent on another person’s tax return.

An individual with other coverage in addition to a plan meeting the minimum deductible 

requirements is still eligible for an HSSA if such other coverage is for permitted coverage or 

coverage that may be provided by permitted insurance, as described above. In addition, an 

individual is treated as uninsured if his or her only coverage is permitted coverage or coverage 

that may be provided by permitted insurance. 

A plan meets the minimum deductible requirements if the plan is a health plan with an 

annual deductible of at least $500 in the case of self-only coverage and at least $1,000 in the case 

of family coverage. These dollar amounts are indexed for inflation. There are no maximum 

deductible requirements and no limits on out-of-pocket expenses. A plan is not a minimum 

deductible plan if substantially all of the coverage is for permitted coverage or coverage that may 

be provided by permitted insurance, as described above.

Tax treatment of and limits on contributions

Contributions to a health account made by an eligible individual are deductible (within 

limits) in determining adjusted gross income (i.e., “above-the-line”). In addition, employer 

contributions to a health account (including salary reduction contributions made through a 

cafeteria plan) are excludable from gross income and wages for employment tax purposes to the 

extent the contribution would be deductible if made by the employee (e.g., in the case of an 

HSSA, subject to the adjusted gross income limits).17 Nondeductible contributions may be made 

to an HSSA by a family member of an eligible individual. In the case of an employee, 

contributions to a health account may be made by both the individual (and family members in the 

 

16 Special rules apply for determining whether a health plan that is a preferred provider 

organization plan meets the requirements of a high deductible plan. 

17 Employer contributions to a health account are excludable from wages for 

employment tax purposes if at the time of payment, it is reasonable to believe that the employee 

will be able to exclude such payment from income (e.g., a reasonable basis to believe that the 

employee’s income is within the applicable adjusted gross income limits for an HSSA).
8

case of an HSSA) and the individual’s employer. All contributions are aggregated for purposes 

of the maximum annual contribution limit. 

The maximum aggregate annual contribution that can be made to an HSA is 100 percent 

of the annual deductible under the high deductible plan.18

The maximum aggregate annual contribution that can be made to an HSSA is (1) $2,000 

for (a) persons with self-only coverage and (b) uninsured individuals with no dependents19 who 

do not file a joint return, and (2) $4,000 for (a) individuals with family coverage and (b) 

uninsured individuals with dependents or who file a joint return. In the case of individuals age 

55 and older, the $2,000 and $4,000 HSSA annual contribution limits are increased by $500 in 

2004, $600 in 2005, $700 in 2006, $800 in 2007, $900 in 2008, and $1,000 in 2009 and 

thereafter. 

The maximum allowable contribution to an HSSA is phased out for taxpayers with 

adjusted gross income20 above certain levels. In the case of individuals with self-only coverage 

(other than individuals filing a joint return), the phase-out range is $75,000 to $85,000. For 

individuals with family coverage and individuals filing a joint return, the phase-out range is 

$150,000 to $170,000. The adjusted gross income limits apply to HSSA contributions from all 

sources (e.g., both individual and employer contributions).

The maximum annual contribution limits for the health accounts are coordinated so that 

contributions to one type of health account reduce the annual contribution limit for the other type 

of health account.21

An excise tax applies to contributions in excess of the maximum contribution amount for 

the health account. The excise tax is generally equal to six percent of the cumulative amount of 

excess contributions that are not distributed from the health account to the contributor.22

Amounts can be rolled over into a health account from an Archer MSA or a health FSA 

on a tax-free basis. Amounts can be rolled over into an HSA from another HSA or HSSA and 

 

18 The annual contribution limit for a health account is the sum of the limits determined 

separately for each month, based on the individual’s status and health plan coverage as of the 

first day of the month.

19 Written declarations releasing a claim to a dependency exemption under section 

152(e)(2) are disregarded in determining whether an individual has dependents.

20 Adjusted gross income is defined generally as under the rules relating to individual 

retirement arrangements (“IRAs”), and is computed after the deduction for contributions to IRAs 

and before the deductions provided by the provision.

21 The contribution limits are also coordinated with contributions to Archer MSAs.

22 Ordering rules apply to determine the nature of any distributed excess contributions 

(e.g., nondeductible family contributions in the case of an HSSA or employer contributions).
9

into an HSSA from another HSSA on a tax-free basis. Rollovers from an HSA into an HSSA are 

not permitted. Rollovers from a health FSA are limited to up to $500 annually (under section 3 

of the bill) and are taken into account under the annual contribution limits. Amounts transferred 

from another health account or Archer MSA are not taken into account under the annual 

contribution limits.

If an employer makes contributions to employees’ health accounts, the employer must 

make available comparable contributions on behalf of all employees with comparable coverage 

during the same period. Contributions are considered comparable if they are either of the same 

amount or the same percentage of the deductible under the plan. The comparability rule is 

applied separately to part-time employees (i.e., employees who are customarily employed for 

fewer than 30 hours per week). The comparability rule does not apply to amounts transferred 

from an employee’s health account, health FSA, or Archer MSA or to contributions made 

through a cafeteria plan.

If employer contributions do not satisfy the comparability rule during a period, then the 

employer is subject to an excise tax equal to 35 percent of the aggregate amount contributed by 

the employer to health accounts of the employer for that period. The excise tax is designed as a 

proxy for the denial of the deduction for employer contributions. In the case of a failure to 

comply with the comparability rule which is due to reasonable cause and not to willful neglect, 

the Secretary may waive part or all of the tax imposed to the extent that the payment of the tax 

would be excessive relative to the failure involved. For purposes of the comparability rule, 

employers under common control are aggregated. 

Taxation of distributions

Distributions from a health account for qualified medical expenses of the individual and 

his or her spouse or dependents generally are excludable from gross income. In general, 

amounts in a health account can be used for qualified medical expenses even if the individual is 

not currently eligible for contributions to the health account.23

Qualified medical expenses generally are defined as under section 213(d) and include 

expenses for diagnosis, cure, mitigation, treatment, or prevention of disease, including 

prescription drugs, transportation primarily for and essential to such care, and qualified longterm care expenses. Qualified medical expenses do not include expenses for insurance other 

than for (1) long-term care insurance, (2) premiums for health coverage during any period of 

continuation coverage required by Federal law, and (3) premiums for health care coverage while 

an individual is receiving unemployment compensation under Federal or State law. In the case 

of HSSAs, qualified medical expenses also include (1) health insurance meeting the minimum 

 

23 However, in any year for which a contribution is made to an HSA, withdrawals from 

the HSA maintained by that individual generally are excludable from income only if the

individual for whom the expenses were incurred was covered under a high deductible plan for 

the month in which the expenses were incurred. The rule does not apply for continuation 

coverage or coverage while the individual is receiving unemployment compensation even if for 

an individual who is not an eligible individual.
10

deductible requirements if no portion of the cost of the insurance is paid by the employer or 

former employer of the individual or the individual’s spouse,

24 and (2) health insurance for 

individuals who are older than age 65 (including Medicare expenses). For purposes of 

determining the itemized deduction for medical expenses, distributions from a health account for 

qualified medical expenses are not treated as expenses paid for medical care under section 213.

Distributions from a health account that are not for qualified medical expenses are 

includible in gross income (except to the extent that the distribution is attributable to a return of 

nondeductible family contributions in the case of an HSSA).25 Distributions includible in gross 

income are also subject to an additional 15-percent tax unless made after death, disability, or the 

individual attains the age of Medicare eligibility (i.e., age 65).

Tax treatment of HSAs and HSSAs after death

Upon death, any balance remaining in the decedent’s health account is includible in his or 

her gross estate.

If the health account holder’s surviving spouse is the named beneficiary of the health 

account, then, after the death of the health account holder, the health account becomes the health 

account of the surviving spouse and the amount of the health account balance may be deducted 

in computing the decedent's taxable estate, pursuant to the estate tax marital deduction.

26 The 

surviving spouse is not required to include any amount in gross income as a result of the death; 

the general rules applicable to the health account apply to the surviving spouse’s health account 

(e.g., the surviving spouse is subject to income tax only on distributions from the health account 

for nonmedical purposes). The surviving spouse can exclude from gross income amounts 

withdrawn from the health account for expenses incurred by the decedent prior to death, to the 

extent they otherwise are qualified medical expenses.

If, upon death, the health account passes to a named beneficiary other than the decedent’s 

surviving spouse, the health account ceases to be a health account as of the date of the decedent's 

death, and the beneficiary is required to include the fair market value of health account assets as 

of the date of death in gross income for the taxable year that includes the date of death. The 

amount includible in income is reduced by the amount in the health account used, within one 

year after death, to pay qualified medical expenses incurred by the decedent prior to the death. 

As is the case with other health account distributions, whether the expenses are qualified medical 

expenses is determined as of the time the expenses were incurred. In computing taxable income, 

 

24 Amounts paid by the employer include salary reduction contributions.

25 Ordering rules apply to determine the extent to which distributions are attributable to 

nondeductible contributions.

26 Sec. 2056.
11

the beneficiary may claim a deduction for that portion of the Federal estate tax on the decedent’s 

estate that was attributable to the amount of the health account balance.27

If there is no named beneficiary of the decedent’s health account, the health account 

ceases to be a health account as of the date of death, and the fair market value of the assets in the 

health account as of such date is includible in the decedent’s gross income for the year of the 

death. This rule applies in all cases in which there is no named beneficiary, even if the surviving 

spouse ultimately obtains the right to the health account assets (e.g., if the surviving spouse is the 

sole beneficiary of the decedent’s estate).

Reporting requirements

Trustees of health accounts may be required to report to the Secretary amounts with 

respect to contributions, distributions, and other matters as determined appropriate by the 

Secretary. In addition, providers of health insurance are required to report information as 

prescribed by the Secretary. 

Effective Date

The provision is effective for taxable years beginning after December 31, 2003.

 

27 The deduction is calculated in accordance with the present-law rules relating to 

income in respect of a decedent set forth in section 691(c).
12

B. Disposition of Unused Health Benefits in Flexible Spending Arrangements 

(sec. 3 of the bill and sec. 125 of the Code)

Present Law

A flexible spending arrangement (“FSA”) is defined under the Code as a benefit program 

which provides employees with coverage under which specified incurred expenses may be 

reimbursed and the maximum amount of reimbursement which is reasonably available to a 

participant for such coverage is less than 500 percent of the value of such coverage.28 A health 

FSA is an FSA that provides for reimbursement of medical expenses.29 Health FSAs are 

typically part of a cafeteria plan and may be funded through salary reduction.30 Health FSAs are 

commonly used, for example, to reimburse employees for medical expenses not covered by 

insurance. There is no special exclusion for benefits provided under an FSA. Thus, health 

benefits provided under an FSA are excludable from income only if they qualify for exclusion 

under sections 105 or 106. 

FSAs that are part of a cafeteria plan must comply with the rules applicable to cafeteria 

plans generally. One of these rules is that a cafeteria plan may not offer deferred compensation 

except through a qualified cash or deferred arrangement.31 Under proposed Treasury regulations, 

a cafeteria plan is considered to permit the deferral of compensation if it includes a health FSA 

which reimburses participants for medical expenses incurred beyond the end of the plan year.32 

Thus, amounts in an employee’s health account that are not used for medical expenses incurred 

before the end of a plan year must be forfeited. This rule is often referred to as the “use it or lose 

it” rule.

Explanation of Provision

The provision allows up to $500 of unused health benefits in an employee’s health FSA 

to be carried forward to the employee’s health account for the next plan year of the health FSA 

or transferred to an HSA or HSSA maintained for the benefit of the employee.33 Amounts 

transferred to an HSA or HSSA are treated as employer contributions for purposes of the HSA 

and HSSA rules. Under the provision, if an individual is not eligible to contribute to an HSA or 

HSSA for the taxable year, the individual may transfer up to $500 of unused health benefits in 

 

28 Sec. 106(c).

29 FSAs may also be used to provide certain other nontaxable benefits, such as dependent 

care.

30 Long-term care insurance cannot be offered through a cafeteria plan. Sec. 125(f).

31 Sec. 401(k).

32 Prop. Treas. Reg. 1.125-2 Q&A-5(a).

33 Section 2 of the bill provides the eligibility rules for contributions to an HSA or 

HSSA.
13

the employee’s health FSA to a tax-qualified retirement plan, a tax-sheltered annuity (section 

403(b)), an individual retirement arrangement (“IRA”), or an eligible deferred compensation 

plan of a State or local government (section 457). An employee’s unused health benefit is the 

excess of the maximum amount of reimbursement allowable to the employee over the actual 

amount of reimbursement made during the year. Amounts transferred are subject to the rules and 

limits on contributions that would otherwise apply to contributions to the transferee plan. 

Effective Date

The provision applies to taxable years beginning after December 31, 2003.
14

C. Exception to Information Reporting Requirements

for Certain Health Arrangements 

(sec. 4 of the bill and sec. 6041 of the Code)

Present Law

Any person in a trade or business who, in the course of that trade or business, makes 

specified payments to another person totaling $600 or more in a year, must provide an 

information report to the IRS (as well as a copy to the recipient) on the payments.34 Reporting is 

required to be done on Form 1099. In general, these information reports remind taxpayers of 

amounts of income that should be reflected on their tax returns and assist the IRS in verifying 

that taxpayers have correctly reported these amounts.

Treasury regulations specify that fees for professional services, including the services of 

physicians, must be reported.35 Treasury regulations also provide a general exception from these 

information reporting requirements for payments made to corporations, except that this exception 

is inapplicable if the corporation is “engaged in providing medical and health care services.”36

Earlier this year, the IRS issued a revenue ruling describing whether employer-provided 

expense reimbursements made through debit or credit cards or other electronic media are 

excludible from gross income.37 The ruling states that “payments made to medical service 

providers through the use of debit, credit, and stored value cards are reportable by the employer 

on Form 1099-MISC under section 6041.”38

Explanation of Provision

The provision provides an exception from the generally applicable information reporting 

provisions for payments for medical care made under either: (1) a flexible spending 

arrangement,39 or (2) a health reimbursement arrangement that is treated as employer-provided 

coverage.

 

34 Section 6041. 

35 Treas. Reg. sec. 1.6041-1(d)(2).

36 Treas. Reg. sec. 1.6041-3(p)(1). These regulations also provide an exception from 

these information reporting requirements if the payment is made to a hospital that is tax-exempt 

or that is owned and operated by a governmental entity.

37 Rev. Rul. 2003-43, 2003-21 I.R.B. 935 (May 27, 2003).

38

 Id.

39 This term is defined in section 106(c)(2).
15

Effective Date

The provision applies to payments made after December 31, 2002.